Question

Net Present Value

Carsen Sorensen, controller of Thayn Company, just received the following data associated with production of a new product:

• Expected annual revenues: $760,000
• Projected product life cycle: five years
• Equipment: $780,000 with a salvage value of $100,000 after five years
• Expected increase in working capital: $100,000 (recoverable at the end of five years)
• Annual cash operating expenses: estimated at $456,000
• Required rate of return: 8 percent

The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems.

Required:

1. Estimate the annual cash flows for the new product. Enter cash outflows as negative amounts and cash inflows as positive amounts.

Year	Cash Flow
0	$
1–4	$
5	$

2. Using the estimated annual cash flows, calculate the NPV.
$

3. What if revenues were overestimated by $152,000? Redo the NPV analysis, correcting for this error. Assume the operating expenses remain the same. Enter cash outflows as negative amounts and cash inflows as positive amounts.

Year	Cash Flow	Present Value
0	$	$
1–4
5
Net present value		$

Answer 1

1.

Year	Cash Flow
0	$       -8,80,000	=-780000 (Equipment) -100000 (Working Capital)
1–4	$ 3,04,000	=(760000 (Revenue) -456000 (CAsh Expenses)) x 4 years
5	$        5,04,000	=304000+100000 (Salvage Value)+100000 (Working Capital)

2.

Year	Cash Flow	PV factor @8%	PV
0	$       -8,80,000	1	$     -8,80,000
1–4	$        3,04,000	3.312	$    10,06,848
5	$        5,04,000	0.6806	$      3,43,022
		NPV	$      4,69,870

3.

Year	Cash Flow	PV factor @8%	PV
0	$       -8,80,000	1	$     -8,80,000
1–4	$        1,52,000	3.312	$      5,03,424
5	$        3,52,000	0.6806	$      2,39,571
		NPV	$     -1,37,005

Annual Cash Flow = $304000 - $152000 = $152000